Option Trade
Cisco Systems, Inc. (NASDAQ:CSCO) Calls 
Monday, May 10, 2015

**OPTION TRADE: Buy the CSCO Jul 2015 30.000 call (CSCO150717C00030000) at or under $0.70. Place a protective stop loss at $0.25, and a pre-determined sell at $1.40.

by Ian Harvey

May 10, 2015

Introduction

Cisco Systems, Inc. (NASDAQ: CSCO), a network and communication provider, is scheduled to report its third-quarter results on May 13. The company will report its results after the market close, with analysts forecasting earnings of $0.53 per share. The stock is up 3.5% on the year.

Cisco has a strong history of outpacing analyst estimates with its quarterly results. The company has consistently topped estimates, and it is believed that it will continue that trend when it announces its third-quarter numbers. Improvements in the overall economy continue to benefit the company, and not only has the company been steadily growing its earnings, it is expected to continue growing in the future. Analysts have forecast 5% earnings growth next year.

The company recently announced a leadership change, with 17-year Cisco veteran Chuck Robbins assuming the role of CEO. Cisco has been undergoing a massive re-organization in recent years, and changing the CEOs is likely to positively impact employee morale, which has been hurt by big layoffs during the re-organization.

Technical Details

Cisco Systems closed at 29.57 on Friday. Cisco Systems has a 52 week low of $22.43 and a 52 week high of $30.31.

The stock’s 50-day moving average is $28.00 and its 200-day moving average is $27.00.

The company has a market cap of $149.21 billion and a price-to-earnings ratio of 17.47.

Earnings

Cisco Systems last posted its quarterly earnings results on Wednesday, February 11th. The company reported $0.53 earnings per share (EPS) for the quarter, beating the consensus estimate of $0.51 by $0.02. The company had revenue of $11.90 billion for the quarter, compared to the consensus estimate of $11.08 billion.

During the same quarter in the previous year, the company posted $0.47 earnings per share. The company’s revenue for the quarter was up 7.0% on a year-over-year basis. Analysts expect that Cisco Systems will post $2.16 EPS for the current fiscal year.

Earnings Forecast

According to Cisco’s own forecast, it expects its year-over-year (or YoY) revenue growth to be 3%–5% in the quarter. This is decent growth, considering that Cisco’s average YoY revenue growth in the last four quarters has been less than 1%.

Cisco Systems’ operations in the region of North America are doing well and Europe is improving. The company is particularly doing well in data centers and switching segments in the U.S. and Europe.

For Cisco Systems, Inc., there is a silver lining to the dark cloud of a stronger U.S. dollar. The company’s expenses are usually in the local currency, which means that the company stands to benefit from the strengthening U.S. currency, which should allow it to channel the cost benefits to discount its dollar prices without the fear of impacting margins.

Reasons to Back Cisco Earnings

Expect Surprise Earnings

CSCO stock posted strong earnings that beat Wall Street expectations handily on both revenue and profits in February. Specifically, Cisco posted EPS of 53 cents, up from 47 cents per share a year earlier and topping forecasts of 51 cents. Additionally, revenue rose to $11.94 billion, up 7% from $11.16 billion last year to top expectations of $11.8 billion. Those numbers are all great — but equally compelling was the jump from a closing price of $26.73 on Feb. 11 to $29.24 on Feb. 12 — more than 9%.

Strength to Continue

Earnings should be strong again because:-

1. Corporate IT departments seem to be better off in 2015 than in previous years.

2. But most importantly, cloud computing and security are in focus, and Cisco is well-positioned to take advantage of these trends.

Benefits from Restructuring

CSCO is more than cutting costs with layoffs; the tech company also has lain off staff at the vice president level and higher. The lower overall headcount coupled with a strategically aligned workforce will help in both the short and long term.

Value is Fair

Cisco has a forward price-to-earnings ratio that is just above 17 right now. That’s quite attractive compared to the S&P and the Nasdaq-100.

Dividend and Buybacks

Since instituting its dividend in 2011, Cisco has increased its payout five times — from an initial 6-cent quarterly payout to its current 21 cents per share. That 250% increase in about four years would be impressive enough, but dividend distributions are still just 37% or so of projected 2015 earnings. That means payouts are not just sustainable, but likely to increase.

Additionally, Cisco reported 5.16 billion shares outstanding last quarter, down from almost 5.33 billion a year ago — close to a 4% reduction in share count in the last 12 months. And with almost $54 billion in cash and investments on the books, there is plenty of dry powder to fuel future dividends and buybacks in any environment.

Share Price Undervalued

Cisco's fair value of its future cash flows reflects a premium of 20% on top of its current share price. Further, the outcome also is in line with Goldman Sachs' $34 price target for Cisco Systems. Therefore, expect the recent rally (the stock is up 29.6% in the past 12 months) to continue after Cisco's Q3 earnings report this week.

Moving Forward

Cisco Partners with Microsoft

According to a May 5 press release, Cisco (CSCO) will provide integrated software solutions to Microsoft (MSFT) that will help enterprises manage their private and public clouds seamlessly. Cisco’s solutions are designed to facilitate enterprises that intend to shift their IT workloads between their own private clouds and Microsoft Azure, a public cloud computing platform. Cisco will provide networking facilities such as routing, VPN (virtual private network), firewalls, and control.

IT Expansion

IT departments are expected to expand spending this year compared to last year. Much of the spending by IT departments in 2015 is expected to be focused on cloud computing and security. Cisco Systems, Inc. is well-placed to take advantage of the spending trends this year to make more sales. In addition to impressive cloud computing offerings, Cisco is also on the right side of security, with the added advantage coming from its acquisition of Sourcefire back in 2013.

Cost Cutting

Cisco is cutting costs through headcount reduction and strategic alignments, which should support continued earnings’ improvements.

Improving Earnings per Share

Buybacks are also helping Cisco to improve its earnings per share. The company has been able to reduce its outstanding shares by 10% so far since 2009, thanks to stock repurchases. Continued stock buybacks combined with improvement in sales should bolster the stock and earnings.

Capital Allocation

Besides the desire to strengthen shares through buybacks, Cisco Systems generally has a shareholder-friendly policy when it comes to capital allocation. The company has been able to raise its quarterly dividend nearly 250% since introduction of dividends in 2011 at $0.06 a share to the current quarterly dividend payout of $0.21 a share. The company also returns value to shareholders through stock repurchases.

Analysts Opinions

Overall, analysts believe there is upside to Cisco’s consensus expectations for the next two quarters.

According to a report last week by Oppenheimer, Cisco Systems, Inc. could be on its way to a big Q2. Oppenheimer’s recent channel checks and supply chain analysis indicates that Cisco is off to a strong start this quarter.

Oppenheimer has an Outperform rating on Cisco and a $32 target on the stock.

Brian White of Cantor Fitzgerald also released a note to investors last week reiterating the firms Buy stance on Cisco Systems.

“With today’s announcement, John Chambers will assume the role of Executive Chairman and continue to serve as the Chairman of the Board. For most investors and analysts on Wall Street, John Chambers is the only Cisco CEO that Wall Street has ever known given that he held the CEO title since 1995 after joining the company in 1991. Over the years, we found John Chambers to be one of the best listeners in the CEO position and gracious with his time with analysts. He was also very passionate about Cisco and he will clearly be missed, in our view; however, we believe he has created a strong bench of executive talent during his tenure.”

White also added, “Our $33.00 price target is based on 11.5x our CY:15 pro forma EPS estimate (adjusted for interest income/expense), plus Cisco’s net cash per share of $6.30. Given Cisco’s dominant position in the networking market, solid execution, strong balance sheet, and healthy dividend yield of 3.1%, we believe this multiple is justified.”

Another analyst at Simona Jankowski of Goldman Sachs has a Bullish stance on the stock. Simona Jankowski issued a note a couple of weeks ago with a Buy rating on the stock and $34.00 price target or 17.32% upside to the last closing price at the time.

“We believe Mr. Robbins’s skill set is most similar to that of Mr. Chambers in terms of customer relationships and leadership potential. That said, we believe Mr. Chambers leaves big shoes to fill. We don’t expect any change in fundamental strategy or capital allocation under Mr. Robbins in the near to intermediate term. Indeed, we believe Mr. Chambers leaves Cisco on a solid course as it relates to its strategy (e.g., around Intercloud and IoT) as well as operating model, thus we expect the focus over the next two years will be more on the execution of that strategy. We maintain our CL Buy.”

The company has also been the subject of a number of other research reports:-

Analysts at Vetr downgraded shares of Cisco Systems from a “buy” rating to a “hold” rating and set a $31.17 price target on the stock in a research note on Thursday, April 16th.

Finally, analysts at Piper Jaffray reiterated a “positive” rating on shares of Cisco Systems in a research note on Monday, April 13th.

Two analysts have rated the stock with a sell rating, ten have assigned a hold rating and twenty-three have issued a buy rating to the stock. Cisco Systems has an average rating of “Buy” and a consensus price target of $29.40.

Conclusion

Wall Street is upbeat on the company, and as long as the company continues to benefit from re-organization changes more strong days are ahead. Outgoing CEO, John Chambers, said that he believes his replacement will grow the company faster than he was able to do, and if this holds true the stock should continue to reward investors.

Therefore, based on the facts above the following options trade is recommended…..


**OPTION TRADE: Buy the CSCO Jul 2015 30.000 call (CSCO150717C00030000) at or under $0.70. Place a protective stop loss at $0.25, and a pre-determined sell at $1.40.



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